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David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures. Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions. Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

Money Market Malaise

There was a decent amount of attention paid to this blog post from the WSJ Marketbeat blog. The sentiment for a cut from the bond and futures markets stems from the concept that what the Fed has done is inadequate to reliquefy the areas that they are targeting. Banks will face significant lending losses, and economic growth will stop, unless the FOMC acts in a major way. We are still waiting (since 5/3) for a permanent injection of liquidity, and we have until Thursday night to see how much good the discount window action has done.

From the “not much good” camp, what good is it if healthy institutions pick up additional excess liquidity at rates above where they could they could borrow unsecured for 5 years in the bond market? Bank of America did not need the discount window down by 0.5% in order to take a stake in Countrywide.

Here’s the current problem. It has been difficult for marginal borrowers to borrow in the Commercial Paper [CP] markets. Even strong names like American Express and Lincoln National went to the bond market to pay off maturing CP. But if you were a lower rated company, things were worse, like H&R Block, or GMAC, things are considerably worse. All they can rely on is pre-existing credit lines. After that, they are dependent on the kindness of strangers.

Now, there is some hint that the troubles in ABCP are becoming more nuanced. Conduits with the highest quality collateral are getting rolled over. But how bad is it for real offenders? It is one of those cases where the ratings agencies are playing catch-up, let us say. Moves from AAA to CCC? Yes. Breathtaking. Sure ruins their ratings migration tables.

For those with time, for a relatively complete article explaining some of the problems that money market funds face from subprime, look here. The risk isn’t the same risk as from asset-backed CP [ABCP] per se, but seems to stem from buying AAA floating rate bonds from CDOs owning tranches of subprime ABS.

Those worrying about the carry trade blowing up can rest for a while. The Bank of Japan decided not to tighten. Japanese lending rates remain low a while longer, and the party goes on. I guess it will take the importation of inflation to make that change.

Beware easy certainties. Just because the Fed cuts does not mean the market will rise, or that if it doesn’t cut, it will fall. On average, it is true the 6 months after a first cut, the market rises, and almost always rises after a full year the first cut.

I previously asked who could benefit from incremental US dollar liquidity. I came up with a few possibilities, but one I did not come up with was Hong Kong, with their link to the US Dollar on one side, and their link to Chinese growth on the other. It is certainly worth a thought.

Full disclosure: long LNC

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About David Merkel

David J. Merkel, CFA, FSA, is a leading commentator at the excellent investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited David to write for the site, and write he does — on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, and more. His specialty is looking at the interlinkages in the markets in order to understand individual markets better.
David is also presently a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. He also manages the internal profit sharing and charitable endowment monies of the firm.
Prior to joining Hovde in 2003, Merkel managed corporate bonds for Dwight Asset Management. In 1998, he joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life.
His background as a life actuary has given David a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that David will deal with in this blog.
Merkel holds bachelor’s and master’s degrees from Johns Hopkins University. In his spare time, he takes care of his eight children with his wonderful wife Ruth. View all posts by David Merkel →